Economics Basics Economics Basics

Demand and Supply Demand and Supply

Supply and demand is perhaps Supply and demand is perhaps one of the most fundamental one of the most fundamental

concepts of economics and it is concepts of economics and it is the backbone of a market the backbone of a market

economy economy

Demand Demand

refers to how much (quantity) of a refers to how much (quantity) of a product or service is desired by product or service is desired by buyers. The quantity demanded is buyers. The quantity demanded is the amount of a product people are the amount of a product people are willing and able to buy at a certain willing and able to buy at a certain price price

the relationship between price and the relationship between price and quantity demanded is known as the quantity demanded is known as the demand relationship demand relationship

SupplySupply

represents how much the market can offer represents how much the market can offer The quantity supplied refers to the amount The quantity supplied refers to the amount

of a certain good producers are of a certain good producers are willingwilling to to supply when receiving a certain price supply when receiving a certain price

The correlation between price and how The correlation between price and how much of a good or service is supplied to much of a good or service is supplied to the market is known as the supply the market is known as the supply relationshiprelationship

Price, therefore, is a reflection of supply Price, therefore, is a reflection of supply and demand. and demand.

The relationship between The relationship between demand and supply determines demand and supply determines

the allocation of resources the allocation of resources demand and supply theory will allocate demand and supply theory will allocate

resources in the most efficient way resources in the most efficient way possible. possible.

How?How? Let us take a closer look at the law of Let us take a closer look at the law of

demand and the law of supply.demand and the law of supply.

The Law of DemandThe Law of Demand The law of demand states that, if all other factors The law of demand states that, if all other factors

remain equal, the higher the price of a good, the remain equal, the higher the price of a good, the less people will demand that good. In other less people will demand that good. In other words, the higher the price, the lower the words, the higher the price, the lower the quantity demanded. quantity demanded.

The amount of a good that buyers purchase at a The amount of a good that buyers purchase at a higher price is less because as the price of a good higher price is less because as the price of a good goes up, so does the opportunity cost of buying goes up, so does the opportunity cost of buying that good. As a result, people will naturally avoid that good. As a result, people will naturally avoid buying a product that will force them to forgo the buying a product that will force them to forgo the consumption of something else they value more consumption of something else they value more

The chart below shows that the The chart below shows that the curve is a downward slope. curve is a downward slope.

A, B and C are points on the demand A, B and C are points on the demand curve curve

  

Each point on the curve reflects a Each point on the curve reflects a direct correlation between quantity direct correlation between quantity

demanded (Q) and price (P) demanded (Q) and price (P)

At point A, the quantity demanded will be Q1 and At point A, the quantity demanded will be Q1 and the price will be P1.the price will be P1.

The demand relationship curve illustrates the The demand relationship curve illustrates the negative relationship between price and quantity negative relationship between price and quantity demanded (inverse relationship)demanded (inverse relationship)

The higher the price of a good the lower the The higher the price of a good the lower the quantity demanded (A), and the lower the price, quantity demanded (A), and the lower the price, the more the good will be in demand (C). the more the good will be in demand (C).

The Law of SupplyThe Law of Supply

Like the law of demand, the law of Like the law of demand, the law of supply demonstrates the quantities supply demonstrates the quantities that will be sold at a certain price.that will be sold at a certain price.

Unlike the law of demand, the supply Unlike the law of demand, the supply relationship shows an upward slope.relationship shows an upward slope.

This means that the higher the price, This means that the higher the price, the higher the quantity supplied the higher the quantity supplied

Producers supply more at a higher Producers supply more at a higher price because selling a higher price because selling a higher quantity at a higher price increases quantity at a higher price increases revenue revenue A, B and C are points on the supply A, B and C are points on the supply

curve.curve.

The Law of SupplyThe Law of Supply

Each point on the curve reflects a Each point on the curve reflects a direct correlation between quantity direct correlation between quantity supplied (Q) and price (P).supplied (Q) and price (P).

At point B, the quantity supplied will At point B, the quantity supplied will be Q2 and the price will be P2.be Q2 and the price will be P2.

Time and SupplyTime and Supply

Unlike the demand relationship, Unlike the demand relationship, however, the supply relationship is a however, the supply relationship is a factor of time. factor of time.

Time is important to supply because Time is important to supply because suppliers must, but cannot always, suppliers must, but cannot always, react quickly to a change in demand react quickly to a change in demand or price. or price.

Supply and Demand Supply and Demand RelationshipRelationship

Imagine that a special edition CD of your favorite Imagine that a special edition CD of your favorite band is released for $20. Because the record band is released for $20. Because the record company's previous analysis showed that company's previous analysis showed that consumers will not demand CDs at a price higher consumers will not demand CDs at a price higher than $20, only ten CDs were released because the than $20, only ten CDs were released because the opportunity cost is too high for suppliers to produce opportunity cost is too high for suppliers to produce more. If, however, the ten CDs are demanded by 20 more. If, however, the ten CDs are demanded by 20 people, the price will subsequently rise because, people, the price will subsequently rise because, according to the demand relationship, as demand according to the demand relationship, as demand increases, so does the price. Consequently, the rise increases, so does the price. Consequently, the rise in price should prompt more CDs to be supplied as in price should prompt more CDs to be supplied as the supply relationship shows that the higher the the supply relationship shows that the higher the price, the higher the quantity supplied.price, the higher the quantity supplied.

Supply and Demand Supply and Demand RelationshipRelationship

If, however, there are 30 CDs produced and If, however, there are 30 CDs produced and demand is still at 20, the price will not be pushed demand is still at 20, the price will not be pushed up because the supply more than accommodates up because the supply more than accommodates demand. In fact after the 20 consumers have demand. In fact after the 20 consumers have been satisfied with their CD purchases, the price been satisfied with their CD purchases, the price of the leftover CDs may drop as CD producers of the leftover CDs may drop as CD producers attempt to sell the remaining ten CDs. The lower attempt to sell the remaining ten CDs. The lower price will then make the CD more available to price will then make the CD more available to people who had previously decided that the people who had previously decided that the opportunity cost of buying the CD at $20 was too opportunity cost of buying the CD at $20 was too high.high.

EquilibriumEquilibrium

When supply and demand are equal (i.e. When supply and demand are equal (i.e. when the supply function and demand when the supply function and demand function intersect) the economy is said to function intersect) the economy is said to be at be at equilibriumequilibrium..

At this point, the allocation of goods is at At this point, the allocation of goods is at its most efficient because the amount of its most efficient because the amount of goods being supplied is exactly the same goods being supplied is exactly the same as the amount of goods being demanded as the amount of goods being demanded

EquilibriumEquilibrium

At the given price, suppliers are At the given price, suppliers are selling all the goods that they have selling all the goods that they have produced and consumers are getting produced and consumers are getting all the goods that they are all the goods that they are demanding. demanding.

EquilibriumEquilibrium

As you can see on the chart, equilibrium As you can see on the chart, equilibrium occurs at the intersection of the demand occurs at the intersection of the demand and supply curve (i.e. at Pand supply curve (i.e. at P* and Q*)* and Q*)

DisequilibriumDisequilibrium

Disequilibrium occurs whenever the Disequilibrium occurs whenever the price or quantity is not equal to P* or price or quantity is not equal to P* or Q*. Q*.

Excess SupplyExcess Supply  If the price is set too high, excess If the price is set too high, excess supply will be created within the supply will be created within the economy and there will be allocative economy and there will be allocative inefficiency.inefficiency.

Excess SupplyExcess Supply  

At price P1 the quantity of goods that the At price P1 the quantity of goods that the producers wish to supply is indicated by producers wish to supply is indicated by Q2.Q2. But the quantity consumers But the quantity consumers demand is at Q1.demand is at Q1.

  Excess DemandExcess Demand  

Excess demand is created when price Excess demand is created when price is set below the equilibrium price.is set below the equilibrium price.

Because the price is so low, too Because the price is so low, too many consumers want the good many consumers want the good while producers are not making while producers are not making enough of it enough of it

Excess DemandExcess Demand  

At price P1, the quantity of goods At price P1, the quantity of goods demanded by consumers at this price is demanded by consumers at this price is Q2, but the goods producers are willing to Q2, but the goods producers are willing to supply is at Q1. supply is at Q1.

Shifts vs. MovementShifts vs. Movement

““movements” and “shifts” in relation movements” and “shifts” in relation to the supply and demand curves to the supply and demand curves represent very different market represent very different market

phenomena.phenomena.

MovementsMovements  

A movement refers to a change A movement refers to a change alongalong a curve (Movement along). a curve (Movement along).

A movement occurs when a change A movement occurs when a change in the quantity demanded is caused in the quantity demanded is caused only by a change in price, and vice only by a change in price, and vice versa. versa.

Movement along the curveMovement along the curve

A movement occurs when a  change in A movement occurs when a  change in quantity supplied is caused only by a quantity supplied is caused only by a change in price, and vice versa.change in price, and vice versa.

Shifts or Movement ofShifts or Movement of

A shift in a demand or supply curve A shift in a demand or supply curve occurs when a good's quantity occurs when a good's quantity demanded or supplied changes even demanded or supplied changes even though price remains the same. though price remains the same. (other things changed)(other things changed)

Shift in or Movement ofShift in or Movement of

Demand CurveDemand Curve

Shift in or Movement ofShift in or Movement of

Supply CurveSupply Curve